Since the COVID-19 pandemic hit the economy in March 2020, economic policy evolved, or devolved, rapidly. The initial CARES Act response paid little attention to incentives or long-term consequences, instead focusing on getting money out the door and propping up workers and businesses during lock-downs. But as the pandemic persisted, the policy-makers remained focused on providing liquidity and public support even as the economy reopened. While the initial policy response showed that “everyone is a Keynesian in a foxhole,” by the time the Biden administration came into office the rationale had changed. Now expanded public support became the end, not a temporary means. Instead of arguing that disincentive effects were of secondary concern in propping up an economy in crisis, many now argue that incentives are of little importance in influencing economic outcomes. The April jobs report may mark an important turning point.
Nowhere has the change in policy focus been more evident than in the labor market. During recessions, the federal government often provides extended unemployment benefits, but it had never increased the payout. The CARES Act changed that, providing an extra $600 per week to unemployed workers on top of state benefits. It soon became clear that the majority of unemployed workers were earning more from these enhanced unemployment benefits than they had on the job. In the midst of a pandemic, with most states in lockdown, and the time-limited benefits may have been justified.
In fact, several economic studies have analyzed the impact of the benefits expansions on employment over the summer of 2020, finding that they had little to no impact on employment. The lockdown and reopening period was unique — never before had the labor market seen such upheaval — and its unprecedented volatility made it difficult to discern the impacts of policy. Further, several factors may have motivated unemployed workers to continue seeking employment despite the enhance payouts: the perilous state of the labor market, the time-limited nature of the benefits extension, and the risk of losing eligibility for benefits if reported.
Rather than recognize the unique circumstances surrounding the early stages of the pandemic, many researchers concluded that higher unemployment benefits categorically do not lead to more unemployment. In other words, incentives don’t matter. In addition to contradicting common sense and economic logic — make unemployment more attractive, and, all else equal, more people will remain unemployed — this assertion is contrary to a long and well-established empirical literature showing that more generous unemployment benefits lead to longer unemployment spells. When benefits expire, there tends to be a large increase in re-employment. Further, states which cut the duration of unemployment benefits in the previous recession saw a sharp reduction in their unemployment rates. But with little concern for such incentive effects, President Biden’s American Rescue Plan, with expanded unemployment benefits through September, became law. Shortly thereafter, some Democrats in Congress began to push for permanently higher unemployment benefits.
But now, with the economy in recovery, market signals are showing that policies designed to mitigate crises can be counterproductive in normal times. Even the states with the most stringent public-health restrictions have loosened if not abandoned them, and nearly all businesses that would reopen have long since done so. Unemployment has fallen dramatically, but long-term unemployment has increased. Higher unemployment benefits are not the only reason the labor supply has fallen, as increased childcare needs have kept parents at home, and health concerns have kept others out of the labor market. But it has become clear that the expanded benefits are restricting employment growth.
Over the past couple months there have been increasing numbers of reports of businesses having trouble hiring, particularly in the restaurant industry. This industry was hit hardest by the pandemic, due to mandated closures, capacity restrictions, and shifts in dining behavior. It is also the largest sector employing low-wage labor, which puts it in direct competition with enhanced unemployment benefits. Although job openings had grown, and new online job listings were well above pre-pandemic levels, the reports and surveys pointing toward labor shortages and hiring difficulties were dismissed as anecdotal. That all ended with the April employment report.
Where should policy go? As is often the case, states are leading the way. Over the past week two states, Montana and South Carolina, have opted out of the federal unemployment expansions. Of these, Montana’s decision to roll four weeks of the federal unemployment expansions into a re-employment bonus, which provides a direct incentive to return to work, seems the most promising. Previous trial programs have found that re-employment bonuses shorten unemployment durations, generate social gains by putting workers back to work, and even reduce the cost of unemployment programs.